Investment Highlights

• CY22 results were largely within our expectation. Out of the 6 companies under our coverage, 5 were in line and 1 below our expectation. All the REITs posted stronger CY22 results YoY (Exhibit 2). The following are the salient highlights of the companies’ performance:
  • The distributable income of IGB REIT, Pavilion REIT, Sunway REIT, YTL REIT and UOA REIT came in within expectations.
  • The distributable income of Hektar was below expectation due to the lower reversal of impairment losses in trade receivable in 4QCY22.
  • QoQ, most of the REITs posted weaker results (except IGB REIT and Pavilion REIT) as a result of higher operating expenses incurred to improve higher activities in malls and hotels as economic activities have normalised. IGB REIT recorded a slight improvement (+1%) QoQ in distributable income as a result of higher occupancy rates in Mid Valley Megamall. Meanwhile, Pavilion REIT’s earnings rose 7% QoQ due to lower maintenance costs for malls.
• Stronger rental reversion for prime retail malls in CY23. The retail footfall and tenant sales at the majority of malls that fall under our coverage have seen a return to pre-pandemic levels, which was mostly attributed to pent-up domestic demand. Moving forward, we foresee that the retail sector will maintain its growth momentum in CY23F on the back of our economist’s private consumption growth forecast of 6.1%. Managements have guided higher rental reversions of 3-6% in CY23F as compared to 0-3% in CY22, particularly for malls situated in prime locations such as Mid Valley Megamall, Pavilion Kuala Lumpur and Sunway Pyramid. However, the rental reversions for less established malls are likely to remain flattish or slightly negative. For these smaller malls, increasing occupancy rates through attractive rent will be imperative.
• Occupancy and rental reversion rates in the office segment are expected to stabilise. Following a downtrend that began in CY20, the average occupancy rate for offices are showing signs of stabilisation since 3QCY22 (Exhibit 4). However, we expect a flattish rental reversion in CY23F, particularly for older office buildings in Kuala Lumpur city centre, given the persistent oversupply of office spaces amid office decentralisation and flexible working arrangement trends.

• Significant growth in the hospitality segment during holiday season. YTL REIT’s occupancy rate for its Australian portfolio has rebounded strongly in 4QCY22 due to increased demand for holiday vacations during the year-end holiday season. Notably, its 4QCY22 average daily rate has reached its historical high at A$311 vs. pre-Covid (2019) level of A$271. Sunway REIT’s occupancy rate is improving gradually, brought on by the arrival of domestic and foreign tourists in Malaysia as well as the return of MICE (Meetings, Incentives, Conferences & Exhibitions) and business events (Exhibit 4). With China’s travel revival coupled with the recovery of Australia and Malaysia’s domestic tourism, we expect the hospitality sector to gradually improve in CY23F/24F and fully recover to pre-Covid levels in CY25F.

• Federal Reserve is likely to maintain its hawkish stance in 1HCY23. In light of the stronger-than-expected economic data as well as stickier inflation readings in January 2023, our in-house economist projects a more aggressive 0.75% Fed rate hike (from 0.5%) in 1HCY23 from the current level of 4.5%-4.75% to tackle persistently high inflation. Meanwhile, the likelihood of a US rate cut by this year is dwindling. This means that the Fed Funds Rate is likely to stay at 5.25%-5.5% towards the end of this year. Pending more clarity from the upcoming Federal Open Market Committee and Bank Negara Malaysia Monetary Policy Committee meetings, we anticipate that the 10-year MGS yield could remain fluid in the near future.
  Nevertheless, we expect to see the impact from the rate hike to be manifested in 2HCY23 with more signs of tapering inflation and US wage growth. This could result in the stabilisation of Fed rate as well as 10-year MGS in 2HCY23. Hence, our in-house forecast on 10-year MGS yield is maintained at 3.8%-4% by the end of 2023.
• Maintain OVERWEIGHT. We believe CY23F will mark a turnaround year for REIT counters after 2 years of hardship, supported by the recovery in retail and hotel segments. Meanwhile, the arrival of international tourists may mitigate any deterioration of domestic consumer spending power under the current inflationary environment. With the gradual recovery in retail footfalls and hotel occupancy rates coupled with potential Fed rate stabilisation in 2HCY23, we are seeing a widening yield spread for REITs against 10-year MGS and expect the REIT sector’s high distribution yields of 6%-10% to appeal to yield-seeking investors.

• Selective criteria. We like REITs with high-quality assets situated at strategic locations and decent dividend yields. We also favour REITs with exposure in retail and hotel segments, both of which are anticipated to further recover in CY23F.

• Our top Buy are Sunway REIT (FV: RM1.76/unit), Hektar REIT (FV: RM0.81/unit) and YTL REIT (FV: RM1.10/unit). For Sunway REIT, our BUY call is underpinned by its diversified investment portfolio which encompasses retail malls, hotels, offices, a university and hospitals that spread across Malaysia, as well as its strong occupancy rates which have exceeded 90% for retail assets. We like Hektar due to its attractive FY24F distribution yield of 9% vs. average yield (excluding Hektar) of 7%. YTLREIT is another of our top picks due to its stable recurring rental income and minimal occupancy risks for its hotel properties in Malaysia and Japan, secured by master lease agreements. The stock also offers an impressive FY24F yield of 10%.

• Downside risks to our forecasts are: (i) higher-than-expected interest rate hikes in US that could weaken the Malaysian ringgit and cause an outflow in MGS, narrowing the dividend yield spreads against 10-year MGS; and (ii) stagflationary risks, which could substantively dampen revenue and earnings prospects due to lower occupancy rates, negative rental reversions and extension of rental rebates offered to tenants.

Source: AmInvest Research - 9 Mar 2023